Nervous About High-Yield Bonds? You Don’t Have to Be.

by Daniel Putnam | May 21, 2013 9:35 am

High-yield bonds are the investment everyone loves to hate right now. Absolute yields are at record lows, and talk of a bubble is rampant with multiple experts weighing in each day to make the case of why the rally’s days are numbered.

For investors who are searching for ways to boost their portfolio’s yield, this represents a conundrum: buy into an asset class sitting at a multiyear high, or settle for lower-risk options that pay nothing?

Fortunately, there’s a third choice that not enough investors are aware of yet: Guggenheim’s BulletShares ETFs, a series of funds that allow investors to invest in high-yield bond portfolios with specific maturity dates. The maturities range from 2013 through 2018, with tickers running in order from BSJD[1] through BSJI[2].

Each fund invests in bonds that mature or are callable in the year in which the fund matures. For instance, all of the securities in the Guggenheim BulletShares 2014 High Yield Corporate Bond ETF (BSJE[3]) mature or can be called away in 2014. As each bond matures, the fund rolls the proceeds into cash, then the fund itself matures on Dec. 31 of that year.

The upshot is that the funds have characteristics similar to investing in individual bonds, but with greater diversification and without the need for the investor to conduct credit research on the issuers — a task for which few individuals have the time or skill level.

All of the funds in the series charge an expense ratio of 0.42%.

This might sound somewhat esoteric, but it’s an approach that has numerous substantial benefits for investors.

In contrast to broad-based high-yield funds such as iShares iBoxx $ High Yield Corporate Bond Fund (HYG[4]) or SPDR Barclays High Yield Bond ETF (JNK[5]), which hold constantly rotating portfolios that never mature, the target funds have a set endpoint. This means that if the high-yield market were to experience a downturn, the owner of traditional funds would absorb a loss that lasts indefinitely. On the other hand, target maturity funds would slowly gravitate to the breakeven point as the maturity dates approach. While there is no upside beyond the fund’s income, the investor also doesn’t have to worry about principal fluctuations since he or she simply has to hold on until the fund matures.

The Guggenheim funds do carry the risk that individual securities in the portfolios will default. In this instance, the investor would receive less principal back upon maturity than he or she would if all of the underlying issuers made their payments as scheduled.

Still, the more immediate concern for investors in high-yield funds isn’t necessarily security-specific defaults, but rather the impact that broader credit conditions and shifts in investor risk tolerance have on the value of their principal.

A prime example is the first 11 months of 2008, during which HYG plummeted 29.4%. While a target-maturity fund also would have experienced a loss, investors at least would have had the peace of mind knowing that they would receive their principal back upon maturity (barring an issuer default).

Investors aren’t giving up much in the way of yield to gain these benefits. While yields on the funds closer to maturity are lower than those on HYG or JNK, the yields are competitive for funds maturing in 2016 and beyond — particularly from a risk-adjusted standpoint.

These high-yield funds aren’t the only options for investors in the target-maturity ETF universe. Guggenheim also offers a series of target maturity funds for investment-grade corporate bonds, with the maturity dates extending to 2020 and tickers ranging from BCSD[6] to BCSK[7]. In total, these funds now have more than $1 billion in assets.

In addition, iShares offers five target-maturity municipal bond funds (2013-2017, tickers MUAB[8] through MUAF[9]) and four corporate bond funds (tickers IBCB[10] through IBCE[11]). Fidelity also offers a series of target-maturity municipal bond funds.

Accretive Asset Management, which manages the indices used in the BulletShares funds, offers a comprehensive description of how target maturity funds work here[12] under the link titled “Target Maturity Bond Funds.”

The Bottom Line

In the past, investors had to choose between funds or “ladders” — a series of individual bonds with staggered maturities. These target-maturity ETFs combine the best aspects of the two choices, and even allow investors to take it one step further by building ladders consisting of funds rather than individual securities.

Those who are looking for yield but are concerned about the dire predictions of the “bubble” in high yield might find these ETFs to be a very compelling solution.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.